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Spending cuts: Both sides exaggerate impact

By Jeanne Sahadi, senior writerMarch 3, 2011: 3:08 PM ET

NEW YORK (CNNMoney) -- Republican spending cuts will destroy the recovery! Republican spending cuts will revive the economy!

Get ready for more of that kind of partisan rhetoric as the clock ticks down to the next deadline on passage of a 2011 federal spending plan. On Thursday, Vice President Biden kicked off talks with House and Senate leaders of both parties.

Truth is the $61 billion in spending cuts passed by the House GOP last month -- which will serve as a baseline in negotiations -- might not be as harmful as Democrats predict or as helpful as Republicans claim.

Democrats are touting economic analyses that suggest a reduction of that magnitude could kill off hundreds of thousands of jobs over the next two years and mute an already slow economic recovery.

Until businesses start creating more jobs, government spending is needed to fill the void, the Democrats argue. They point to recommendations of debt commissions and fiscal hawks, who have urged caution at making too many cuts too soon.

Republicans, by contrast, are touting the views of economists who argue that making notable cuts now could encourage businesses to hire and invest because it would be a sign that lawmakers are taking steps toward reining in the country's debt.

"The high unemployment we are experiencing now is due to low private investment rather than low government spending," Stanford University economist John Taylor wrote in a recent blog post. "By reducing some uncertainty and the threats of exploding debt, the House spending proposal will encourage private investment."

Who's right? Who knows.

"Both sides are likely overstating their position, which is hardly surprising," said Stan Collender, veteran budget expert and founder of the blog "Capital Gains and Games."

Why it's not so black and white

Democrats say it would be harmful to reduce government spending this year as much as the House GOP proposed.

In fact, the GOP bill likely will not reduce actual spending in 2011 by $61 billion. That's because the bill would reduce $61 billion in so-called budget authority, which is the amount permitted but not necessarily the amount spent in a given year.

According to estimates from the Congressional Budget Office, actual outlays this fiscal year under the bill would be $9 billion higher than they were in 2010, and only $17 billion lower than the CBO originally assumed for this year.

The bottom line is that some of the $61 billion reduction wouldn't take effect until 2012.

Republicans, meanwhile, claim that the House GOP bill would boost confidence among businesses and investors, if not immediately then over time. That's hard to verify, and the U.S. Chamber of Commerce and the Business Roundtable did not return calls for comment.

But presumably spending cuts would only boost confidence if they meaningfully improve the debt situation, which the House GOP bill will not.

It won't reduce the deficit by $61 billion. And even if it did, that would represent less than 4% of the anticipated deficit for 2011 and less than 0.4% of the country's $14.1 trillion total debt accrued to date.

How to really build confidence

What all fiscal experts believe could boost confidence, however, is a long-term, comprehensive debt reduction plan. Federal Reserve Chairman Ben Bernanke said as much in a Congressional hearing on Wednesday.

Bernanke said if the House GOP bill were passed as is in isolation it could cost the economy about 200,000 jobs over two years.

But, he added, "if you coupled that with a long-term plan that really shaved the deficit, I think that the overall effect could be much more favorable."

And economists at Goldman Sachs, who estimate that the $61 billion bill might reduce economic growth in the second and third quarters but didn't offer job-loss estimates, noted that the debates over the timing of cuts and what could boost confidence might be remedied by imposing new budget rules.

"For instance, imposing hard, enforceable caps on discretionary spending levels for the next few years would likely be viewed by the market as a credible policy and could increase confidence in the sustainability of the U.S. fiscal position."